Aquarius Platinum: if you can swallow the risk the upside seems to be on offer

Platinum, Platinum, Platinum – what a useful metal and what a volatile price! In June of 2008 you could buy an ounce for $2036, by Christmas of the same year it was going for $840. The main consumers of the metal are the auto-industry, a wide variety of industrial processors and of course the jewellery industry. Given this, the collapse in platinum prices towards the end of 2008 is not a huge surprise, but a huge disappointment. Just imagine running a platinum mining company, if anything you would need a CFO with some nerve!

London-listed Aquarius Platinum (AQP) seems to have a CFO with the right attributes. Looking at the company’s name there is no mistaking that it is in the platinum business, and it did have to manage its books going through the brutal price turbulence last year. The company managed well by successfully re-capitalizing and is now looking to expanding its assets.

Aquarius operates in South Africa (80% of world’s platinum reserves) and Zimbabwe. The 9,000 employees and contractors of the company labour on seven sites. The company’s assets include whole or partial ownership of Chromite Re-treatment Plant and Kroondal Mine (46% of total production, lifetime to year 2016), Everest Mine (currently partially suspended due to subsidence; 14% of production, lifetime to year 2016), Mimosa Mine (19% of production, lifetime to year 2039), Marikana Mine (17% of production, lifetime to year 2020), Platinum Mile tailings re-treatment facility and recently acquired Blue Ridge Mine with minelife to year 2027.

Aquarius is the fourth largest (455,675 ounces mined in year to June 2009) and the lowest-cost platinum producer in the world (cash cost per PGM ounce mined $644). The strategies deployed by the management, to achieve the leadership position in the industry, are a) to bring into operation smaller-scale deposits b) to deploy capital intensity rather than labour intensity to increase utility and safety c) to utilise contractors for mining and processing d) to outsource smelting and marketing for greater cash flow security. 

Current company capital structure is made up of $76m worth of debt (all non-current) and $608.2m worth of equity. Debt to Capital Ratio is hence a very comfortable 11.1%. The weighted average cost of capital equals 15%. There are two reasons for the seemingly high cost; 1) South Africa commands a 2.4% market premium in its cost of equity calculation, and 2) company stock has a fairly high volatility at Beta of 1.69.

For the reasons of world Platinum price collapse in the financial year of 2009 and partial closure of one of company’s mines (Everest), the revenue for the year has come in at $310.6m ($919m in previous reporting period). With a reduction in revenue such as this, and in such a short space of time no matter how nimble you are in controlling cost, avoiding falling into the red is just beyond doable. Net Annual Income has thus ended up at negative $45.7m to 30th June 2009 ($236.5m in previous reporting period). Things that did not help included a) FX losses due to wild fluctuations between SA Rand, US and Zimbabwean Dollar, and b) impairment charges in connection with partial closure of Everest. Annual EPS to 30th June 2009 totalled negative $0.13 ($0.92 in previous reporting period).

The Balance Sheet has been strengthened during the year by timely re-capitalisation. Liquidity is very good at Current Ratio of 4.5. Cash Balance stands at $153.6m. The only points worth noting on the Balance Sheet would be $92m of deferred tax liabilities, which would drain cash-flow at a point in the future and $65m of closure costs relating to Everest (although this may be wholly or partially covered by insurance, which the company has already received; the amount of this insurance could not be disclosed in company books, as the insurance company insisted on the figure being confidential).

Net Operating Cash-Flow for the year was $12m ($339m in previous reporting period). As Cash Out-Flow from Financing Activities drained $73.4m, Equity Holders ended up with negative cash flow for the year of 2009. Nevertheless, the CEO indicated during the latest conference call that the dividend payments may resume in 2010.

Looking at the share price chart of the company (at least in last financial year) it is quite easy to mistake it for the price chart of platinum. Aquarius share price trend seems to currently be on the up and technical traders are without doubt finding opportunities. But what about the fundamental investors? Is the current share price of £2.87 justified?

Considering Aquarius operation in economically stable environment we have a net income margin of about 20% of revenues (averaged out over 2008/7/6/5). This, together with fairly modest CapEx (next year projected to be around $40m) gives us a very profitable core business. Plugging these values into FCFE model gives us an intrinsic value for the business of around £4 a share.

Using a Return on Equity of an impressive 30% (averaged out over 2008/7/6/5), Price Earnings model gives us intrinsic value for Aquarius of just over £4 a share.

Given the seemingly obvious upside to the company stock it is no surprise that the shareholders have been so willing to back the company restructuring exercise in 2009. The company is essentially a commodity investment; if you can swallow the risk the upside seems to be on offer.

Next quarterly report is due 30th September.